Investing is all About Riding the Bigger Bike

From the desk of risk:

The trader sums his gains. The investor compounds her returns.

When I was a kid, we used to have bike races through the neighborhood. One particular race on a summer evening featured a 1.5 mile route, a fit 12-year-old on a dirt bike, and a slightly pudgy 10-year-old on a ten-speed. Of course, the ten-speed was a much bigger bike so it was going to be an interesting race. Those not racing would follow along on their bikes or wait at various points along the route. A few bets were made (mostly trading cards) and the race was on.

The race began exactly as would be expected – the older boy on the smaller dirt bike jumped out to an enormous lead. At one point, the distance between the two riders was somewhere between two to three hundred yards. But . . . slightly past the halfway point, the younger boy on the ten-speed pulled ahead. In the end, it wasn’t even close.

Why did the younger boy win? It certainly wasn’t skill. Nor was it strength or endurance. The reason the younger boy won is very simple. He had a bigger bike with bigger wheels.

Much has been made about the difference between the trader and the investor. The exact distinction is not important. Those who are traders know who they are – investors as well. And both types will often proudly self-classify. We could construct numerical examples to show how one would outperform the other under various scenarios. All such examples would quickly be rejected as contrived by those who would disagree.

So over the long run, who will win the race – the investor or the trader? A trader may have the exact pulse of the market and have decades of investment experience. A trader may even be able to successfully avoid the worst of market drawdowns. A personal investor may only glance at their investment portfolio on a quarterly or annual basis. But who has the bigger bike?

The one with the bigger bike has the tax benefit of long-term capital gains, whose investment contributions are on autopilot, who receives income from investment and then immediately reinvests those proceeds regardless of market level. The bigger bike belongs to the one who does not wait for the perfect time to jump onto the market train, does not sit on excess cash, and doesn’t read too much into daily headlines. The one with the bigger bike is the one who thinks in terms of return rather than dollar gain.

So why is this kind of post coming from the desk of risk? The race between the trader and investor is really a race between math on autopilot coupled with favorable tax treatment and disciplined but imperfect human decision making. We all think we can beat the machine. Very few of us, however, can truly comprehend or patiently await exponential growth that’s spread over decades. The key question is this: when you race, which bike will you choose?

The information in this article has been derived from sources believed to be accurate. Information derived from sources other than Principal Global Investors or its affiliates is believed to be reliable; however, we do not independently verify or guarantee its accuracy or validity.

The information in this article contains general information only on investment matters and should not be considered as a comprehensive statement on any matter and should not be relied upon as such. The general information it contains does not take account of any investor’s investment objectives, particular needs or financial situation, nor should it be relied upon in any way as a forecast or guarantee of future events regarding a particular investment or the markets in general. All expressions of opinion and predictions in this document are subject to change without notice.

Subject to any contrary provisions of applicable law, no company in the Principal Financial Group nor any of their employees or directors gives any warranty of reliability or accuracy nor accepts any responsibility arising in any other way (including by reason of negligence) for errors or omissions in this article.

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